5Green finance: the EU’s Sustainable Investment Taxonomy (update)25
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This EU document is legally and politically important because:
Action
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Overview
5.1In April 2020, the EU agreed on a “Sustainable Investment Taxonomy“ Regulation,26 a new statutory classification system that will be used by European financial institutions, investors and regulators to determine whether a particular economic activity can be said to contribute substantially to one of six high-level environmental objectives, such as climate change adaptation or pollution prevention27 (to establish, in turn, the degree to which investment in that activity could be considered sustainable and conducive to that objective, as an aid to environmentally-conscious investors).28
5.2Notably, the new Regulation will oblige the 27 EU Member States to use the Taxonomy as and when legislating for “any measures setting out requirements [for] […] financial products or corporate bonds that are made available as ‘environmentally sustainable’”, for example when introducing a statutory “green bond“ label (on which the European Commission launched a consultation in June 2020). In addition, from the end of 2021 onwards,29 it will require financial companies that sell investment products in the EU to either make regular disclosures to investors about the extent to which their products can be considered ‘sustainable’ under the terms established by the Taxonomy, or include a disclaimer that a particular investment product does “not take into account the EU criteria for environmentally sustainable investments”. In December 2020, the European Commission is due to publish the first detailed “screening criteria” that will be used to determine whether an economy activity contributes to one of the six high-level environmental objectives.
5.3We last reported on the Taxonomy to the House and other interested Select Committees in our Report of 30 April 2020. At that time, we also noted that the new disclosure requirements for firms offering sustainable investments were not expected to apply in the UK as a matter of EU law, because they will become operational only from 31 December 2021 (and therefore well beyond the scheduled end of the post-Brexit transitional period at the end of this year).30 We did, however, ask the Treasury to clarify if the Government would take the EU’s new system for classifying investments by sustainability as a model for a future UK approach.
The Government’s position
5.4The Economic Secretary to the Treasury (John Glen MP) wrote to us on 28 May 2020 with further information on the potential implementation of the EU’s taxonomy in the UK beyond the end of the post-Brexit transition period.
5.5In his letter, the Minister explained that Articles 4 to 8 of the Regulation, which principally cover disclosure requirements for those offering investment products with respect to the impact of their offerings on environmental sustainability, will only take effect from late 2021 onwards. Under section 3 of the European Union (Withdrawal) Act 2018 (“the 2018 Act”), an EU Regulation becomes retained UK domestic law only if it is “in force and applies immediately before [the end of transition]”. As such, those disclosure requirements will not remain on the statute book automatically when the transitional period ends.
5.6By contrast, the remainder of the Regulation — in particular the requirement for any statutory “green finance” schemes to take into account Taxonomy’s six high-level environmental objectives, and how those are defined — will begin to apply in July 2020, twenty days after its publication in the EU’s Official Journal on 22 June. This, the Minister stated, “effectively means that the UK will retain the framework for the taxonomy” in its domestic law at the end of the transition period. Under section 8 of the 2018 Act, the Government can use Statutory Instruments to correct “deficiencies” in the Taxonomy that will remain part of UK law. While the Minister notes the Treasury intends to use this power to “ensure it is fully operable from the end of the [transition] period”,31 he did not clarify which actual changes to the Regulation are foreseen in this regard, especially with respect to the establishment of the detailed screening criteria for each of the six environmental objectives set out in the Taxonomy.
5.7As regards the broader policy choice of whether to retain the Taxonomy under UK law in the longer term, the Minister added that the detailed implementation of the EU’s new framework — the detailed ‘screening’ criteria to determine to what an extent an economic activity contributes to one of the high-level environmental objectives — are yet to be published by the European Commission. This, he argued, means there is no “clarity on the final outcome of the file” and therefore “we cannot comment at this stage on the extent to which we will align with the EU after the [transition] period” (our emphasis).
The Committee’s assessment
5.8The Economic Secretary to the Treasury has clarified that some substantive elements of the EU’s new Taxonomy to classify investment opportunities by their impact on environmental sustainability will remain part of UK law under the terms of the European Union (Withdrawal) Act 2018, but notes that the choice of whether to retain the Taxonomy domestically beyond the end of the transition period, and if so in which form, has not yet been made.
5.9There are two elements of the Minister’s letter of 28 May 2020 that deserve further attention:
5.10First, there is the general question of the longer-term retention of the EU Taxonomy under UK law. Here, the Minister states the “taxonomy will play an important role in the development of Green Finance”. He then, curiously, refers to the need for the Government to have seen the European Commission’s detailed screening criteria for the Taxonomy’s six environmental objectives — due to be published in stages from the end of 2020 onwards — to get “clarity on the final outcome” of this new EU framework, adding that he therefore cannot yet “comment […] on the extent to which we will align with the EU”. We do not know why the Minister explicitly raised the possibility of alignment with the EU on the Taxonomy as part of the future UK-EU economic relationship. In our Report of 30 April 2020 we asked him only “to clarify whether [it] is considering establishing a similar legally-binding Sustainability Taxonomy domestically for investment products”.
5.11However, the reference to “align” may be linked to the Government’s on-going discussions with the European Commission about “equivalence” in financial services. This is the arrangement, which we discussed in more detail in our Reports of 26 March and 14 May 2020, under which the Government is seeking preferential market access into the EU for Britain’s financial services exports after the UK leaves the Single Market.32 It is not clear if the EU is seeking commitments from the Government that it will retain a version of the Taxonomy under its domestic law, in return for such “equivalence” for the British asset management and investment services industries (nor how any such commitment would be compatible with the Government’s own insistence that the UK “will not agree to any obligations for our laws to be aligned with the EU’s”).
5.12Moreover, the question of alignment with the EU is separate from the issue of whether the Government intends to retain the Taxonomy as such as a UK statutory arrangement in the first place. The European Commission’s detailed rules for implementation of the new ‘green’ screening process are not due to apply from early 2022 at the earliest, well beyond the scheduled end of the transition period. It is therefore entirely possible for the Treasury to instead work on its own “screening criteria” to complement the Regulation as retained EU law, if the Government intends to keep the Taxonomy on the UK statute book. The European Commission’s proposals in this regard may be relevant or helpful, but they are not a precondition for such a policy choice.
5.13Secondly, Parliament should pay close attention to any Statutory Instruments laid by the Treasury to correct “deficiencies” in the Taxonomy as it applies in UK law from the end of the transition period. We note that the powers granted to the Government under the 2018 Act to do so appear to preclude in this instance a complete repeal of the Taxonomy Regulation, given that — in the words of the Act — it cannot be said to have no “practical application in relation to the United Kingdom […] or is otherwise redundant or substantially redundant”. However, the Government will need to decide how it seeks to modify the process for establishing the aforementioned “detailed screening criteria” for the Taxonomy to the UK’s situation after the end of the transition period.
5.14In particular, under the EU Regulation, those crucial technical rules would be set by the European Commission, but subject to a veto by either the European Parliament or by a qualified majority of EU Member States in the Council.33 What process the Government foresees for the establishment of the UK’s own sustainability screening criteria (if, indeed, it intends to retain the Taxonomy in the longer term), including any role for Parliament and the proposed new Office for Environmental Protection, or some other independent body, is unclear.
Action
5.15It follows from our assessment above that it is not possible at this stage to determine how the EU’s Sustainable Investment Taxonomy might be applied to statutory “green finance” schemes or financial market participants in the UK beyond the end of the post-Brexit transition period.
5.16Given these uncertainties, the Committee is writing to the Economic Secretary to the Treasury, to seek clarification around his remarks regarding potential UK regulatory alignment with the EU on the Taxonomy. We have also asked the Minister to inform us, any other Select Committees with an interest, in due course when any draft legislation is published that would amend the Regulation establishing the Taxonomy as it applies in domestic law after the end of the transition period. A copy of that letter is shown in the Annex to this chapter.
5.17There are also a number of other EU policy initiatives which are linked to the Sustainable Investment Taxonomy, and which may also be relevant for the UK in the future (even if only as a comparator for the Government’s future proposals with respect to ‘green finance’). These include a series of European Commission reports planned for 2021 and 2022 that will assess when an activity does not contribute meaningfully to sustainability34 and evaluating the “effectiveness of […] this [Taxonomy] Regulation in channelling private investments into environmentally sustainable economic activities”.35 As noted, the European Commission in June 2020 also launched a consultation on an EU “green bond” label (which could lead to the introduction of a voluntary or binding product label for such investment products based on the Taxonomy at EU-level).36 The Committee will continue to monitor these related developments and report any relevant implications for the UK to the House, as necessary.37
5.18We draw the Treasury’s update, and our assessment thereof, to the attention of the Environmental Audit Committee and the Treasury Committee, who may wish to pursue this matter further with the Government in light of their own work in this area.
Letter from Sir William Cash MP to the Economic Secretary to the Treasury, (John Glen MP)
UK implementation of the EU’s Sustainable Investment Taxonomy
Thank you for your letter of 28 May 2020 on the EU’s new Sustainable Investment Taxonomy to assess the environmental impact of investment in particular economic activities, and its potential implications for UK investors and financial institutions.38 We note the Regulation establishing the Taxonomy has now been formally approved by both the European Parliament and the Member States in the Council, and was published in the Official Journal of the EU on 22 June.
The Committee was intrigued by the reference in your letter to the fact that the Government is apparently considering “the extent to which we will align with the EU” as regards the Taxonomy beyond the end of the transition period, based on the detailed screening criteria for the high-level environmental objectives which the European Commission is due to begin publishing at the end of this year. It would be helpful if you could clarify why such alignment is under consideration, and in particular whether the issue of the UK operating something akin to the Taxonomy has been raised, or is likely to be raised, in the context of discussions with the EU on ‘equivalence’ for financial services (especially with respect to asset management and investment services).
We would also be grateful if you could inform us, and any other Select Committees with an interest, in due course when any draft legislation (under section 8 of the European Union (Withdrawal) Act 2018 or otherwise) is published to amend the Regulation establishing the Taxonomy as it applies in domestic law after the end of the transition period. If the Government intends to retain a version of the Taxonomy in the longer term, we believe Parliament should take a particular interest in any Government proposals relating to the process for establishing the UK’s own detailed screening criteria for the environmental objectives set out in the Taxonomy.
We look forward to receiving your response as regards alignment with the EU Taxonomy in the customary 10 working days.
25 Proposal for a Regulation on the establishment of a framework to facilitate sustainable investment; Council and COM number: 9355/18 + ADDs 1–2, COM(18) 353; Legal base: Article 114 TFEU; Department: HM Treasury; Devolved Administrations not consulted; ESC number: 39806.
26 The Taxonomy is part of a larger package of EU measures — the “Green Finance“ package — that aim to ensure the financial services industry plays its part in the fight against climate change. The overall aim of the proposals is to channel more investment into sustainable activities by incorporating ‘Environmental, Social and Governance’ (ESG) considerations into investment industry practices. The Commission argues this would benefit the environment and lead to more sustainable economic growth (as well as being in the industry’s own interest by reducing insurance claims related to environmental damage and ensuring the viability of long-term investments). The Regulation was formally approved by the Member States in the Council on 15 April 2020 and by the European Parliament on 17 June 2020, and published in the Official Journal of the EU on 22 June 2020 as Regulation 2020/852.
27 The six environmental objectives for which the Sustainability Taxonomy sets criteria to determine whether an economic activity is of benefit are: climate change adaptation and mitigation; sustainable use and protection of water and marine resources; the transition to a circular economy; pollution prevention and control; and the protection and restoration of biodiversity and ecosystems.
28 More concretely, to be classified as ‘sustainable’ under the Taxonomy, an economic activity will have to “contribute substantially” to one of the environmental objectives; avoid any “significant harm” to the environmental objectives; and meet certain “minimum social safeguards” in the form of ILO Conventions.
29 The European Commission is currently working on detailed screening criteria to implement the Taxonomy Regulation, with an initial focus on developing ways of measuring an economic activity’s impact on climate change mitigation and adaptation.
30 While the Withdrawal Agreement with the EU provides for the possibility of extending the transition period, and therefore the supremacy of EU law, for a period of up two years until 31 December 2022, Section 15A of the European Union (Withdrawal) Act 2018 states that “a Minister […] may not agree […] to an extension of the [transition] period”.
31 By way of example, the Government will need to use this power at the very least to remove references to the need for the European Commission to conduct an evaluation of the Regulation since this would clearly not be relevant under UK domestic law.
32 At the end of the transition period, British financial institutions automatically lose their “passport” to operate in any EU Member State using their UK licence.
33 Under the Regulation, the detailed screening criteria would be made by means of Delegated Acts, a type of EU statutory instrument.
34 That report will also assess the possibility of introducing more detailed preconditions with respect to social and employment conditions for an activity to qualify as ‘sustainable’.
35 These reviews are also likely to give some Member States an opportunity to push for amendments to the Taxonomy Regulation, given that the legislation is not without its detractors among the remaining 27 EU Member States, with Sweden voting against while Austria, Bulgaria, Hungary and Poland abstained from the final vote. The legislative process to establish the current version of the Taxonomy already highlighted a number of areas of controversy between the EU’s Member States and the European Parliament. Notably, EU countries were divided on whether energy generation from nuclear power and gas should be considered ‘sustainable’, which has resulted in ambiguities in the legal text. The final Regulation also contains a category of “transitional” activities, which could allow activities otherwise classified as non-sustainable, like for example nuclear energy or steel manufacturing, to be classified as ‘sustainable’ if there is “no technologically and economically feasible low carbon alternative” and the activity “has greenhouse gas emission levels that correspond to the best performance in [its] sector or industry”. The extent to which the Regulation defines sustainability in terms of forestry management was also controversial.
36 In June 2019, the EU’s Technical Expert Group on Sustainable Finance published a report on an “EU green bond standard”.
37 The Committee will also continue to pursue the broader matter of “equivalence” with the EU on financial services regulation with the Treasury, especially as regards the extent to which that arrangement could require continued UK regulatory alignment with EU financial services rules more generally.
38 Document 9355/18 + ADDs 1–2, COM(18) 353; 39806.
Published: 1 July 2020